FEATURE ARTICLE, FEBRUARY 2006

TEXAS TICS 101
Real estate investors in the Lone Star State are seeing the value of tenants-in-common.
Todd Williams

Tenants may be a common problem facing real estate investors today, and the solution may be tenants-in-common, or TICs. Real estate investors throughout Texas have seen the value of their investments double if not triple during the last few years; however, they may be tired of dealing with the problems that accompany those investments, such as tenants, toilets and trash. Those investors looking to cash in on their newfound wealth may find that they face substantial taxes unless they choose to utilize a 1031 tax exchange, which allows investors to trade properties without having to pay the capital gains tax. Thanks to IRS Revenue Procedure 2002-22, investors can now exchange their equity into a TIC, which is a fraction of a larger institutional property, such as an office building, apartment complex or retail center, that may have a higher cash flow, greater tax deductions and zero management.

Internal Revenue Code Section 1031 allows investors to sell property that they currently hold for productive use in trade or business or for investment and defer their capital gains tax if they reinvest the proceeds into a another property held for productive use in trade or business or for investment. The hitch is that they must retain a “qualified intermediary” to hold the funds from the sale property, identify the replacement property within 45 days and close on it within 180 days. The clock starts ticking upon the close of their sale property. Furthermore, the investor must buy a property of equal or greater value, reinvest all equity, and obtain equal or greater debt. This underutilized tax code allows real estate investors to reinvest their capital gain rather than pay taxes on it. Under current tax law a real estate investor can do an unlimited number of tax exchanges and defer taxes indefinitely so long as he does not sell the end property or properties. It is a so-called tax-free, life-long loan from the government to buy real estate.

When exchanging property, 1031 investors must be cautious that they don't trade one set of problems for a new set of problems. TICs are an increasingly popular option for those investors seeking to exit day-to-day property management, increase cash flow on equity and increase tax deductions in their real estate portfolio. TICs are usually a direct participation investment whereby a real estate sponsor would offer fractional ownership in a piece of commercial property. Rather than being a sole owner, the investor buys a portion of a larger piece of real estate and takes title to that portion as a tenant-in-common so that he may do a 1031 tax exchange. A typical TIC investment would include 35 or less investors pooling their equity to purchase an office building, apartment complex or retail center. The sponsor generally negotiates the purchase of the property, obtains financing and manages the property. If done correctly, the investor shares in the cash flow of the property as well as the tax benefits and appreciation without any of the management headaches. Of course if there are losses, the investor would share in those as well.

TICs are generally sold as securities by licensed and trained financial advisors. Whenever an investment in a common enterprise is offered to the public and there is an expectation of profits based solely on the efforts of others, it must be sold as a security. These types of investments are highly speculative and are not risk free, and therefore an investor must meet strict suitability requirements.

The TIC industry has grown into a multi-billion dollar industry in a very short time, and Texas has been a recent hot bed of activity. There are 13 TIC sponsors located in Texas and 22 TIC sponsors have offered TIC investments in Texas, according to Brady Flamm of Omni Brokerage. For investors thinking about selling their property and doing a 1031 tax exchange, they should consult their CPA as well as a reputable qualified intermediary and good financial advisor.

Todd Williams is the director of TIC offerings for Argus Realty Investors. Argus Realty Investors has purchased several TIC properties in Texas.

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